Modernizing Russia in a challenging global environment

Dear Mr Mau, It is a great pleasure to participate in the Gaidar Forum and I thank you for this invitation to address such a knowledgeable audience. The Gaidar Forum is a famous event opening the year in Moscow and allowing us to reflect on the global and Russian economic outlook as well as to discuss the role of Russia in the global economy.

2013 will be a critical year for the world economy, hopefully a turning point in the exit from the crisis. 2013 will also be a critical year for the relationship between Russia and the OECD. We are now working full speed on Russia’s accession to the OECD, and are also cooperating actively on the Russian G20 presidency.

Let me first say a few words on the global economic outlook, which has deteriorated, again. We are indeed far from being out of the woods. We project a hesitant and uneven recovery for the OECD area over the next two years, around 1.4% in 2013 and 2.3% in 2014. Yet again! The euro area will remain in or near recession well into 2013. Growth is expected to pick up in the US and Japan, but only gradually, while a quicker recovery is expected in the emerging economies. In this grim context, the Russian economy will continue at above 4 per cent in 2012 and 2013, a projection, however, much dependant on oil prices evolution.

But hard times are also times of opportunities. In Russia like in the OECD, governments must act decisively to address the long standing structural problems that have weakened their economies. They must also act together, particularly within the G20, to put the global economy on a renewed growth path. And here Russia’s leadership will be requested. Russia is indeed a critical player on the international scene, needless to say. Its leadership is even more prominent now in 2013 with its Presidency of the G20. There are high expectations on this Presidency, and a growing feeling of scepticism on the G20 capacity to fulfil its mission. But I am convinced that the Russian presidency might achieve great results. The OECD stands ready to support it as it has for previous Presidencies.

But to be able to fully play this leading role, Russia needs to modernize its economy. Its strengths are well-known: first of all a very little public debt, a quite enviable situation nowadays. Russia also enjoys high labour force participation and a high level of education. In some areas, like space technology, Russia is even at the frontier. Its GDP per capita gap relative to the upper half of the OECD narrowed rapidly prior to the crisis. And we are now seeing renewed convergence.

However, in spite of its rich natural and human endowments, the Russian economy is still relatively backward. It has a low productivity and per capita income, and low access to and use of ICT. It suffers extreme inequality as well as poor outcomes on health and the environment. Its trend growth has fallen well below 4% and remains heavily dependent on natural resource extraction. The share of oil and gas in exports has even increased further since the crisis. Moreover, very unfavourable demographic trends will weigh on growth potential going forward and put the social system under extreme pressure. To modernize its economy, Russia thus faces critical challenges: a structural challenge, a social challenge, an environmental challenge and an institutional challenge. Let me focus on them.

Russia first faces a critical structural challenge to reduce its dependence on oil revenues. It needs particularly to insulate its public budget from oil price fluctuations. This is not new and is well recognized by the Russian government.

Diversifying the economy will require raising productivity growth, and there is considerable room to do so. In this regard it is crucial to increase competition, including by making product market regulation less restrictive and by reducing the role of the state in the economy. This should be coupled with a serious reform of state-owned enterprises’ governance, to ensure inter alia that they operate under competitive neutrality rules. Opening further the economy is also crucial and in this regard WTO accession should have very positive results.

A lot can be done too to stimulate innovation.

However, the modernization of the economy will not happen without tackling Russia’s huge social challenges. Right now, Russia suffers from an exceptionally high income and regional inequality and from health outcomes well below those of OECD countries. In a nutshell, Russia needs to invest urgently in the quality of its human capital.

This requires first of all a more efficient and better-funded healthcare system. Russia needs to increase public health care funding and ensure a fair and efficient distribution of these resources. Prevention policies however remain critical, in particular to reduce alcoholism and tabagism that lead to high premature mortality among men of working age.

On the social policy front, a lot might be done to reduce the high relative poverty - 17% of the population compared with an 11% OECD average. And here the strongest shoulders should bear a fair share of the cost of social protection. Income taxation progressivity should thus be increased, as well as earnings levels over which social security contributions are due. The family policy could also focus more on reducing in-work poverty among families. Finally, it is crucial to enhance the financial sustainability of the pension system.

Much remains to be done also to improve the functioning of the labour market, at the heart of income inequality, and thus to strike a better balance between labour market flexibility and workers’ income security. This implies redressing the uneven bargaining power between workers and employers and providing more effective support to the unemployed.

Last but not least, the education system needs a serious overhaul. With the highest level of educational attainment in the world, Russia’s educational performance as measured by PISA ranks below most OECD countries. There is also a significant mismatch in skills’ demand and supply. It is thus crucial to update the curricula in the VET system, to encourage greater engagement of employers in it, as well as to improve adult education and life-long learning.

Besides developing its human capital, Russia needs to preserve its natural capital. It still has one of the most energy-intensive economies in the world. It is the fourth largest user of energy and the third largest emitter of greenhouse gases. Moreover, it has one of the highest rates of premature mortality attributable to air pollution.

The environmental challenge and scope for energy efficiency investment is thus huge. This should be a policy priority and a lot is indeed happening, including in relationship to the OECD accession. Ambitious targets have been established as well as a long-term strategy last year. But progress is very slow. So far the policy measures and instruments indentified appear insufficient, as well as financial resources. Indeed, only 0.2% of the government budget is allocated to environment. And here again, implementation is lacking.

To progress further, less emphasis should be put on administrative measures and more on financial incentives. This implies first of all accelerating the installation of meters for energy and water use, then removing subsidies for domestic energy use, while assisting low-income households via the tax and benefit system. It also requires reforming the environmental tax system and seriously upgrading waste management practices. Last but not least, environmental and green growth considerations need to be integrated in the long-term socio-economic strategy. This is challenging everywhere, even more in Russia.

Let me now delve on the last but not least challenge, the institutional one, which remains colossal. Russia indeed needs to improve on three critical and related points: the efficiency of its public administration, its business climate and the level of corruption.

A more open, competent and accountable public administration is badly needed. It is indeed a prerequisite to design and implement the necessary reforms to achieve a sustainable and inclusive growth. A lot has already been done in this regard, but more is needed. This will require inter alia the implementation of access to information provisions and a comprehensive strategy to engage citizens much more in the policy process.

The poor business climate is another glaring and persistent handicap for the Russian economy. Doing business in Russia is difficult and risky, due to the heavy administrative burden, the widespread corruption and a weak rule of law. While certain improvements have been achieved, more comprehensive, energetic and consistent policy action is needed. It is urgent for example to cut red tape significantly and to reduce the quantity while raising the quality of laws and regulations. Strengthening the protection of whistleblowers is also necessary; as well as reinforcing judicial independence and law enforcement in general. This remains a huge work in progress. But it is crucial, as the implications are wide-ranging and serious, including low competition, sluggish innovation and low investment. This thus threatens the overall economic diversification strategy.

Ladies and gentlemen,Russia is facing huge challenges. It is incredibly rich in natural and human assets. To modernize itself and thus diversify, it needs to invest in these assets and to preserve them. The reform agenda is daunting, covering structural, social, environmental and institutional reforms. A lot has already been done but implementation remains a critical challenge.

In all these areas, the OECD accession process provides a useful opportunity to take stock of convergence, and to identify both the progress as well as the areas where the gaps are still large. Drawing on OECD experience and peer review process may be particularly useful to Russian policy makers. It will help them design and implement these critical reforms. OECD accession should thus not be seen as an end in itself, but rather as a conduit for improving policy-making and economic performance. It will be a strong catalyst for Russia’s own modernisation agenda.

2013 will be a critical year for reforms in Russia, for Russia’s leadership and for its accession to the OECD. It will thus be a critical year for all of us. Let us work together to make sure it is a successful one.